How Yahoo China Missed Out On The Mainland

In China, tough rivals and serious blunders have left the portal in turmoil

If any U.S. Internet company should have done well in China, it's Yahoo! Inc. (YHOO ) The Net powerhouse was early to the mainland, establishing a unit there in 1999, well before most U.S. dot-com rivals. With Yahoo Japan, the company already had a big success in the region. And Yahoo co-founder Jerry Yang was born in Taiwan to a father from the mainland, making him something of a local hero.

Yet Yahoo China has suffered numerous management missteps and now trails competitors by a wide margin. The latest setback came on Nov. 27 when President Xie Wen stepped down "for personal reasons" after just 42 days on the job.

Yahoo's travails in China hurt, and not just because Yang's reputation in the mainland might be tarnished. With more than 123 million people online, China is an important growth market for any Net company. Yahoo, No. 14 on this year's BusinessWeek 50 list of the best-performing large companies, faces challenges at home in trying to catch Google Inc. (GOOG ) in search ads and sheer buzz. So it's important that it succeed in China.

That goal looks more elusive each day. The company got a black eye early this year when U.S. pundits and politicians pilloried it for cooperating with Chinese authorities in the arrest of a dissident who had a Yahoo China e-mail account. As a portal, Yahoo lags behind local rivals Sina.com and Sohu.com. So a year ago, Yahoo China decided to focus on search and redesigned its page with an uncluttered look similar to Google's. But after just five months, Yahoo switched back to the busier look of a portal. Today it's a distant third in search behind market leader Baidu.com. "Yahoo still hasn't made a major impact in China," says Duncan Clark, managing director of Beijing consulting firm BDA China Ltd.

To set things right, Yang last year transferred the China operation to Alibaba.com, which runs online auction sites in the mainland. In exchange, Yahoo paid $1 billion for a 40% stake in Alibaba. The partnership has hardly been a stellar success. Yang and Alibaba CEO Jack Ma have known each other for years, but industry watchers say there have been disagreements between China managers and California headquarters, and Xie quit shortly after he and Ma returned from a trip to the U.S. to discuss strategy. Yahoo declined to comment, but a spokesman for Alibaba says there haven't been significant disputes.

SPYWARE SHENANIGANS

Yahoo China also faces accusations by a former executive that it spreads malware, software that installs itself without permission. The charges come from Zhou Hongyi, who became general manager in 2003 when Yahoo China bought Zhou's search engine. In August, 2005, Zhou resigned and soon landed at Qihoo.com, a Net search outfit backed by U.S. venture funds such as Sequoia Capital. Qihoo distributes an anti-spyware program that identifies Yahoo China's toolbar as malware and zaps it from computers. Zhou says that while he worked at Yahoo, the strategy was to distribute the toolbar widely and get users to unwittingly visit sites via pop-up windows. Now he claims he wants to make amends with Qihoo's program. "I opened the Pandora's box, so I should do something to close it." Yahoo China has launched an unfair competition lawsuit against Zhou in Beijing. Zhou has filed a defamation suit of his own.

Despite the turmoil, there's some good news. In November Yahoo China won a suit brought by the China Confederation of Anti-Rogue Software, a local anti-malware group. And Morgan Stanley (MS ) analyst Richard Ji says Yahoo China registered a 16% increase in repeat visitors over last year, vs. 3% for Baidu and a drop of 2% for Google. "Although its market share is small," says Ji, Yahoo "is very sticky."

By Bruce Einhorn

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